Short-term inflationary risk not a major concern for business, say practitioners

As lockdowns slowly lift and vaccination rates in the US, UK and Europe continue to rise, much of the Western world seems set for a sharp rebound in economic activity this summer. However, CFOs and economists are mindful, but unconcerned that the rebound in economic activity will trigger an inflationary risk worth adjusting their annual business strategy.

“Governments will not be too concerned about modest rises in the price level as they would have the desirable side effect of reducing the real value of their debt and government debt has increased substantially during the pandemic,” according to Dr Hilary Ingram, an economist at Lancaster University.

Central banks have asserted that a dramatic shift in monetary policy is not required in the near-term to offset a rapid rise in inflation.

In its latest monetary policy report, the Bank of England said it expects the UK economy to grow as much as 7.25 percent in 2022. Meanwhile, the ECB and the US Federal Reserve predicts growth of 4.4 percent and 6.5 percent in 2021, respectively.

The Bank of England also expects inflation to settle below its two percent by the end of this year. Across the pond, the US Federal Reserve affirmed last month that it plans to keep interest rates steady between 0 and 0.25 percent.

Ingram did not offer a long-term prediction of whether the Fed would alter interest rates, but pointed out that US President Joe Biden has refuted that the US economy is overheating, and that in the short-term any movement on interest rates is unlikely.

“US consumer prices rose at an annual rate of 4.2 percent which was above economists’ projections of 3.6 percent and was the highest increase since September 2008. Inflation increased 0.8 percent on a monthly basis which compares to the forecast of 0.2 percent,” says Ingram. “What we really need to watch is the figures in July and August as by then the effects of the commodity price slump of Spring will drop out of the year-on-year comparisons.”

She added that this was likely to result in more subdued inflation but, if not, central banks “may well raise rates”.

“Interest rates are very low and a modest quarter per cent rise is not likely to change firm strategies,” Ingram said.

Ken Cadematori, senior VP and CFO at GuideOne Insurance in New York, says a robust enterprise risk management system is “critical” to assessing the risks of heightened inflation brought on by the economic recovery.

“This risk requires proactive monitoring, various scenario analysis to understand the potential financial implications, and the development of levers that can be accessed as needed,” Cadematori said.

He added that there hasn’t been holistic inflation for a significant period of time.

“In the recent past, we have only experienced aspects of inflation that we have been able to manage, such as social inflation impacting casualty claims and inflation of property claims due to the increased demand for materials,” he said.

When asked how he would hedge this risk, Cadematori said “robust scenario analysis must be performed across the enterprise that reflects the potential impact on pricing, claims, operating costs and investments.”